A serious business person has a complex solution concept illustrated by glowing glass light bulb in his hand with graph charts, numbers, lines, calculations.

 

What Is The Alternative Minimum Tax (AMT)?

The alternative minimum tax (AMT) is effectively an extra tax that certain taxpayers must pay in addition to their regular income tax. The purpose of the AMT is to prevent taxpayers with substantial income from using tax "loopholes" (such as certain exclusions, deductions, and credits) to pay little or no tax. Through the AMT, these taxpayers must pay at least a minimum amount of tax.

The AMT is based on an alternative set of rules for calculating income tax. A separate accounting method is used to govern the recognition and timing of income and expenses. If you're subject to the AMT, you must compute both your regular tax and your AMT. If your AMT liability is greater than your regular income tax liability, the difference is reported as an additional tax on your federal income tax return. In effect, you're liable for either the AMT or the regular income tax, whichever amount is higher.

How Do You Know If You're Subject to the AMT?

The IRS provides a worksheet in the Form 1040 and 1040A instructions to help you determine if the AMT applies to you. If it does, you must complete IRS Form 6251 to figure out how much tax you owe. The IRS also offers an Alternative Minimum Tax (AMT) Assistant for Individuals on its website (www.irs.gov). You may have to pay the AMT if your regular taxable income, plus certain AMT adjustments and preferences, is more than a specified exemption amount.

Tip: Estates and trusts must use Schedule I of Form 1041. Different rules may apply.

Over time, an increasing number of middle-income taxpayers have become subject to the AMT. There are several reasons for this expansion. For example, regular federal income tax rates have dropped without a corresponding drop in the AMT rates, and some middle-income taxpayers simply have substantial deductions.

Although several factors could give rise to AMT liability, be on the lookout for the following issues on your tax return:

  • Large amounts of state and local taxes paid
  • Large capital gains
  • The exercising of a large incentive stock option

Some of these issues are treated differently for AMT purposes and could trigger AMT liability for "ordinary" taxpayers. For example, although a standard deduction reduces your regular income tax liability, the standard deduction is ignored when computing your AMT. That brings us to AMT preferences and adjustments.

What Are AMT Preferences and Adjustments?

Certain tax benefits available under the regular tax system — such as the deduction of state and local taxes paid — are reduced or eliminated when computing your alternative minimum taxable income (AMTI). Therefore, these tax benefit items — called AMT preferences and adjustments — can generate AMT liability. You must list these tax preferences and adjustments on Form 6251, and they must be added to or subtracted from your regular taxable income (before personal exemptions) to arrive at your AMTI.

The following chart shows how tax benefit items are treated under the regular tax system and under the AMT system.

Item

Regular income tax — Form 1040

Alternative minimum tax — Form 6251

Standard deduction

Subtracted from AGI.

Not allowed. If used on Form 1040, add back full amount.

Taxes

State income tax, real estate tax, etc., are deductible within limits.

Not allowed. Add back any taxes deducted on Schedule A.

Home mortgage interest

Deductible (subject to limits), if loan secured by home.

Interest deduction is allowable only on loans used to buy, build, or improve your main or second home. Interest deduction on refinanced amounts in excess of the original mortgage is not allowed. Add back any amount of disallowed interest deduction.

Refund of state and local taxes

Added to income if previously deducted.

Tax refunds are not included in income. Enter negative amount on Form 6251.

Investment interest

Interest expense relating to tax-exempt interest income is not deductible.

Interest expense relating to tax-exempt private activity bonds is deductible, subject to limits.

Depreciation after 1986

Choice between General Depreciation System and Alternative Depreciation System.

Special depreciation rules must be applied. Consult a tax advisor for more details.

Adjusted gain or loss

Gain or loss from the sale of property is generally included in taxable income.

Gain or loss from the sale of property must be recalculated for AMT if adjusted tax basis of property was affected by AMT adjustments such as depreciation, circulation costs, research costs, mining development costs, or the AMT rules affecting incentive stock options. (This adjustment can be positive or negative.)

Incentive stock options

Exercise of a qualified incentive stock option is generally not a taxable event.

Difference between amount paid to acquire the stock under the incentive stock option and the fair market value of the stock must be added for AMT unless the stock is sold later in same year.

Passive activities

Loss limited to passive activity income.

Gains or losses must be recalculated by taking into account all AMT adjustments and preferences that apply (including any recomputed passive activity loss carryforwards).

Beneficiaries of estates and trusts

Amounts shown on Schedule K-1 (Form 1041) are reported on beneficiary's federal income tax return.

An adjustment for the estate's or trust's AMT items will be shown on Schedule K-1, Form 1041.

Tax-exempt interest from private activity bonds issued by state or local governments after August 7, 1986

Exempt from income tax. Allocable interest expense not deductible.

Amount of income generally must be included for AMT. Income may be reduced by allocable expenses that were not deductible on Form 1040.*

Circulation expenditures

Expenses incurred to increase the circulation of a newspaper, magazine, or other periodical are generally deductible in the year incurred or paid.

Must be capitalized and amortized over three years. Add back difference between current deduction and amount allowed with three-year amortization.

Depreciation prior to 1987

Accelerated or straight-line depreciation available.

Amount of depreciation in excess of amount allowed under straight-line method must be added back for AMT. Consult a tax advisor for more details.

Long-term contract

Depends on accounting method.

Generally must use percentage of completion method. There are certain exceptions for home construction contracts.

Research and experimental costs

Generally may be deducted, amortized, or capitalized.

Must be amortized over 10 years. Add back difference between current deduction and amortized amount allowed.

Intangible drilling costs

Deductible currently or may elect to write off over 60 months.

If 60-month write-off is not elected, costs in excess of 65% of net income from well must be written off over 120 months. Enter difference between amount deducted and amount allowed.

At-risk limitation

Loss limited to amounts at risk.

Gains or losses must be recalculated by taking into account all AMT adjustments and preferences that apply.

Mining costs

Deductible currently or may elect to write off over 10 years.

Must be capitalized and amortized over 10 years. Enter difference between current deduction and amortized amount allowed.

Pollution control facilities

Basis of certain assets can be amortized over 60 months.

Basis of certain assets must be depreciated under the Modified Accelerated Cost Recovery System for facilities placed in service after 1998 and the Alternative Depreciation System for facilities placed in service before 1999. Enter difference between amortized deduction and depreciation deduction allowed.

Tax shelter farm activities

Loss may be limited under passive or at-risk rules.

Gains or losses are recalculated for AMT purposes only if not a passive activity.

Depletion

Depletion deduction allowed.

Deduction must be recalculated using allowable AMT income and deductions. Limited to basis recalculated under AMT rules.

Patronage dividend

May be taxable or nontaxable.

If taxable, cooperative will provide taxpayer with information on how much to include as an AMT adjustment.

Gain from qualified small business stock

50%, 75%, or 100% capital gain exclusion for Section 1202 stock, depending on date stock acquired.

7% of excluded gain is added back. For the sale or exchange of qualified small business stock acquired after 9/27/10, the 100% exclusion of gain from income for regular income tax purposes applies to the AMT calculation as well.

* In general, interest on specified private activity bonds (reduced by any deduction not allowed for computing regular tax, but which would have been allowed if the interest was includable in gross income) is included for purposes of calculating the AMT. This does not apply to private activity bonds issued after July 30, 2008, which are (a) qualified mortgage bonds, (b) qualified veterans' mortgage bonds, or ©) exempt facility bonds issued as part of an issue 95 percent or more of the net proceeds of which are used to provide qualified residential rental projects. The interest on private activity bonds issued in 2009 and 2010 is also not included in the AMT calculation.

Dual Basis Assets and Capital Gains

In some cases, an asset may have one basis for regular income tax purposes and a different basis (usually higher) for AMT purposes. (Generally — but not always — your "basis" in an asset is what you paid for it, plus or minus certain adjustments. Your adjusted basis is the portion of the asset that shouldn't be taxed when you sell the asset.) When there's a tax basis difference, the AMT capital gain or loss won't be the same as the regular capital gain or loss. See the "adjusted gain or loss" section of the above table.

For instance, exercising an incentive stock option isn't usually a taxable event for regular income tax purposes. However, you may have to report income for AMT purposes when you exercise an incentive stock option. The difference between your exercise price and the fair market value of the stock on the exercise date is considered an adjustment for AMT purposes. So, you might have to pay AMT in the year you exercise an incentive stock option. However, your AMT basis in the stock is increased by the amount of the adjustment. This could create a smaller capital gain when you sell the stock. If you overlook this basis adjustment, you might end up paying too much tax.

How Do You Calculate Your AMT?

Individuals make their AMT calculations on IRS Form 6251. Although this form looks complicated, calculating your AMT really involves three major steps.

Request Guide TRG

Compute Your Alternative Minimum Taxable Income (AMTI)

Essentially, the starting point is generally line 10 of your Form 1040, which is your taxable income. This amount is then increased by your total tax benefit items (i.e., tax preferences and adjustments) as calculated on Form 6251. The result is your AMTI.

Subtract Your AMT Exemption Amount

You are entitled to an AMT exemption amount. This exemption was designed to prevent the AMT from applying to taxpayers with modest incomes. The amount of your exemption is phased out as your AMTI reaches higher levels. The exemption is subtracted from your AMTI to determine the amount of your AMTI that is subject to tax at the AMT rates.

The AMT exemption amounts for 2020 are:

Filing status

Maximum exemption

AMTI exemption phaseout threshold

Married filing jointly or qualifying widow(er)

$113,400

$1,036,800

Single or head of household

$72,900

$518,400

Married filing separately

$56,700

$518,400

The AMT exemption amounts for 2019 are:

Filing status

Maximum exemption

AMTI exemption phaseout threshold

Married filing jointly or qualifying widow(er)

$111,700

$1,020,600

Single or head of household

$71,700

$510,300

Married filing separately

$55,850

$510,300

Your exemption phases out if your AMTI exceeds the thresholds indicated above. More specifically, your exemption is reduced by 25 percent of the amount by which your AMTI exceeds the applicable threshold for your filing status. If your filing status is married filing separately, then, prior to calculating your exemption amount, your AMTI is increased by 25 percent of the excess of AMTI over $745,200 (in 2020; $733,700 in 2019) up to $56,700 in 2020 ($55,850 in 2019).

Tip: In 2020, the AMT exemption amount is limited for children under the kiddie tax threshold age to the lesser of $72,900 ($71,700 in 2019) or the child's earned income plus $7,900 ($7,750 in 2019).

Multiply the Remainder by the AMT Rate

After subtracting your exemption amount, multiply the remainder by the applicable AMT rate(s). Applicable AMT rates are 26 percent and 28 percent:

AMT 26% and 28% Rates

Maximum exemption

AMTI exemption phaseout threshold

AMTI at or below this amount taxed at 26%, above at 28%

$194,800

$197,900

Married filing separately

$97,400

$98,950

Generally, the resulting figure is your tentative minimum tax (TMT). Compare your TMT with your regular income tax. If the regular tax is higher, you don't owe any AMT. But if the regular tax is lower, the difference between the two taxes is the amount of AMT you must pay in addition to your regular tax (if any).

Example(s): Your regular income tax is $50,000. When you calculate your tax using the AMT rules, you come up with $62,000. Therefore, you must pay $12,000 of AMT in addition to the $50,000 of regular income tax.

Can You Reduce Your AMT Liability With Personal Tax Credits?

You can offset your AMT liability with personal refundable tax credits including the earned income credit and the refundable portion of the child tax credit. For tax years after 2007, you can also offset AMT liability with nonrefundable personal tax credits, including (among others):

  • The adoption tax credit
  • The child and dependent care credit
  • Nonrefundable portion of child tax credit
  • The tax credit for the elderly or the disabled
  • The American Opportunity tax credit and Lifetime Learning credit
  • The tax credit for IRAs and retirement plans ("savers" credit)

What Is The AMT Credit for Prior Year Minimum Tax?

If you paid AMT last year, you may be entitled to an AMT credit this year. AMT preferences and adjustments can be divided into two categories: permanent differences ("exclusion items") and timing differences. Permanent differences involve items that can be deducted for regular income tax purposes, but not for AMT purposes. Miscellaneous itemized deductions fall into this category. Timing differences involve items — such as depreciation — that are deducted differently for AMT and regular tax purposes. Usually, timing items allow you to delay reporting income. If you paid AMT last year because of timing differences, you can claim a credit (the minimum tax credit) against your regular income tax this year for the amount of AMT attributable to those timing differences.

Calculating the Credit

Your current year credit is figured on IRS Form 8801, and you'll need to refer to last year's Form 6251. Basically, you use information from last year's Form 6251 to calculate what last year's AMT would have been without deferral (timing) items. This amount is subtracted from last year's actual AMT to arrive at a minimum tax credit on deferral (timing) items. Credit carryovers from previous years are added to this amount. The credit allowed for this year is the excess of current year regular tax over current year AMT.

Example(s): Assume you had $7,000 of AMT credit available from year one. In year two, your regular tax liability is $36,000. Your tax calculated under the AMT rules is $31,000. You don't have to pay AMT in year two because your regular tax is higher than the tax calculated under the AMT rules. In addition, you are allowed to claim $5,000 of AMT credit in year two ($36,000 minus $31,000), reducing your regular tax to $31,000.

Tip: The amount of AMT resulting from timing difference items may be carried forward indefinitely and is available as a credit against your regular tax liability in future years. Form 8801 allows you to compute the amount of AMT that results from such items and is used to carry the credit forward. However, since the AMT credit may only be applied against your regular tax liability, it generally may not be used in any year in which you are liable for AMT.

 

 

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of  The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

 

The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that focuses on transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.

 

The Retirement Group is a Registered Investment Advisor not affiliated with FSC Securities and may be reached at www.theretirementgroup.com.



RetireKit Ad

Tags: Financial Planning, Lump Sum, Pension, Retirement Planning